Research and Development Credit - R&D Expense IRS Directive

Effective September 11, 2017, the Internal Revenue Service (IRS) introduced a Research and Development (R&D) Credit Directive for taxpayers that report R&D costs on GAAP audited financial statements, pursuant to ASC730 reporting standards. The directive allows a “safe harbor” expense treatment pursuant to ASC 730 guidelines, which the IRS accepts as qualified R&D expenses in claiming the R&D tax credit with modifications.

To qualify for the safe harbor, a large business and international (LB&I) taxpayer (assets equal to or greater than $10 million) must report as a line item or as a footnote disclosure in its certified audited financial statements the amount of R&D expense pursuant to ASC 730. It is important to note that the directive does not limit the taxpayer's ability to claim and support R&D expenses outside the safe harbor amount, but requires the taxpayer to reconcile financial statement ASC 730 R&D costs to tax Qualified Research Expenses (QREs) reported on Form 6765.

Taxpayers seeking to use the safe harbor will have to establish the needed organizational reporting levels and structure of employees whose costs are expensed as ASC 730 financial statement R&D, as well as identify the appropriate financial information to complete the required Appendices. Companies that currently do not disclose ASC 730 financial statement R&D in their financial statements but want to participate in the safe harbor going forward will have to identify, compute, and report those amounts so they can be presented in future audited financial statements. The directive only applies to original tax returns that are timely filed (including extensions) on or after September 11, 2017.

If these documents are not voluntarily attached to a taxpayer's return, the IRS audit team at the beginning of its examination of the taxpayer's research credit will verify whether the taxpayer has followed or plans to follow the directive.

Taxpayers also will be required to retain and make available to the audit team upon request the underlying documentation that supports the amounts claimed on Appendices C and D. The directive includes a non-exhaustive list of such documentation.

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